How Outdated Budget Rules Are Holding Back American Industrial Policy
As the U.S. government takes a greater role in private businesses, antiquated accounting rules are forcing agencies to make suboptimal decisions. A new method of accounting for equity stakes could modernize them.
In 2018 Congress passed the Better Utilization of Investments Leading to Development Act. The act created a new agency, the U.S. International Development Finance Corporation (DFC), authorized to deploy a wide array of financial instruments to pursue development and U.S. foreign policy goals. Perhaps most notably, this new “on-budget” federal agency, meaning a government department subject to the annual budget and discretionary appropriations process, could make discretionary equity investments in individual companies and funds to achieve those goals. Although the U.S. government has held ownership interests in private companies over the past seventy-five years (primarily in response to economic crises), the DFC’s explicit authority to take equity stakes marked a shift in U.S. economic policymaking: the proactive effort to invest in companies to influence their decision-making.
Over the past eight years, the DFC’s equity program has invested in nearly seventy funds, companies, and projects abroad. Congress also recently enabled the DFC to invest in higher-income countries (formerly, the DFC was restricted to investments in developing nations). Meanwhile, in the past two years, the Trump administration has used authorities at the Departments of Energy, Commerce, and Defense to obtain stakes in U.S. companies. The arrangement is straightforward: companies receive federal financial assistance, and in exchange, the U.S. government gains a say in their business. Although many of the U.S. government’s recent equity investments are actually warrants that ride on the back of traditional government loans, equity investing has undeniably become established government practice.
The debate over whether the U.S. government should hold equity stakes in individual firms appears to be settled, as members of the market-skeptical left, the populist right, and a surprising assortment of finance-oriented centrists have all cheered the U.S. government’s newfound influence over public and private companies. While recent lawsuits (like the one brought by shareholders of Intel) may limit certain federal agencies’ authority to invest in companies, other agencies have found strong legal footing to demand ownership rights in exchange for financial support.
The Case for Equity
The U.S. government has expressed three primary motivations for holding equity stakes in individual companies over the past decade.
The best rationale, and the original purpose of the DFC, is that equity as a financial instrument is the best tool to create a desired government policy outcome. This could include incentivizing further private funding (i.e., “crowding in”), derisking specific investments that are aligned with American interests (for example, when the U.S. government’s participation on a company’s capitalization table protects it from third country nationalization), or offering a particular sector an extremely patient source of capital that prioritizes long-term stakeholder objectives over short-term, returns-driven choices.
The second rationale, the most common historically, is that sometimes the government must take some control of important companies during economic crises. The U.S. government has performed this backstop and bailout function for the U.S. economy since the nation’s inception, and with increasing frequency since the Great Depression.
The final rationale is the most controversial but is increasingly supported by members of both parties: the U.S. government, as a proxy for the American people, should receive some of the wealth generated from government subsidies. That argument focuses on the returns that would have been generated for taxpayers from early government loans to companies such as Tesla or firms that benefit from massive government investment in research and infrastructure, such as Anthropic, OpenAI, and SpaceX.
Combined, these three justifications have motivated the executive branch’s demands for equity authority over the past decade, culminating in a notable surge in government dealmaking during the second Trump administration.
Paying for America’s Investment Tools
As the government invests in an increasingly diverse array of companies—and other on-budget agencies like the Department of Defense seek DFC-like direct equity authority, as contemplated in the upcoming National Defense Authorization Act—policymakers need to answer an important series of practical budgetary policy questions.
Today, the accounting system for the U.S. government, meaning the way it measures both when and how much money the executive branch can spend, can be described in two simple directives:
- Record cash in (i.e., funds appropriated)
- Record cash out (i.e., funds obligated/outlaid)
These two directives are a vast oversimplification of the accounting rules that move funds through the machinery of the federal government, but they are a good way to grasp how the U.S. government manages discretionary federal spending. Each year, Congress and the president enact budget authority in law for a specific period. This time-bound legal authority to spend appropriated funds allows federal agencies to incur obligations, meaning the often-contractual promise to spend on goods, services, or other activities. Outlays occur when actual payment for those promises is made.
Discretionary dollars are typically treated on a cash basis. Government loan programs, however, are allowed to borrow from the U.S. Treasury General Fund the difference between a loan’s upfront cash requirements and a calculated subsidy cost contribution that must use formally appropriated discretionary funds.
While this standard cash treatment works well for managing the government’s administrative spending—federal salaries, direct benefits, state funding, or grantmaking—today’s annual budget and appropriations process divorces U.S. discretionary spending from the government’s balance sheet. The rules that govern the deployment of U.S. taxpayer dollars (or their measurement by the Congressional Budget Office) have grown increasingly ill-suited for managing more complex financial instruments such as the purchase of securities, hampering the DFC and similar agencies.
Without updates to this system, government programs will continue to creatively bend and break the norms and laws governing discretionary funds. This issue pre-dates the second Trump administration and, unless addressed, will lead the government to use certain types of financial instruments like oddly structured loans, insurance products, or guarantees over other more fit-for-purpose options. Managers of government programs may then seek to leverage suboptimal financial tools to move resources out the door however possible, rather than choosing the right tool for the relevant policy problem.
The DFC’s equity program serves as a stark warning. As budgetary pressures on the agency have increased, its use of equity tools has declined year over year since their peak in 2022. The DFC receives about $1.0 billion each year in annual appropriations, which it can choose to invest via insurance, debt, equity, or other financial instruments. When accounting rules allow the agency’s debt and insurance instruments to stretch limited funds farther, the DFC has an incentive to eschew the use of equity, which might be a more appropriate instrument.
The recent expansion of the DFC’s authorities to invest in high-income countries intensifies this problem. Equity instruments can be better tools to achieve the U.S. government’s development or foreign policy objectives in those jurisdictions, as borrowing costs may be relatively low and capital readily available to companies and projects. Ownership in a fund or company can then allow the DFC to influence decision-making directly, rather than through financial incentives at the margins.
The use-or-lose nature of annual appropriations also encourages poor programmatic decision-making. Sound U.S. industrial policy and economic statecraft require programs that inject subsidized capital over an extended period to create a sustained U.S. advantage. Those programs should not have to make bad spending choices or suboptimal investments due to arbitrary time-based budgeting considerations. “No year” funds, which remain available if unspent, or longer duration “multi-year” appropriations are the best option to fund these programs, but often anathema to Congress, as they effectively limit congressional control over the executive branch. This oversight is critical at times, particularly amid escalating levels of government graft and corruption, but harms the pace and quality of investment programs as they mature.
The Equity Budgeting Problem
Improving the administrative and budgetary treatment of equity requires understanding the special rules for U.S. government loan programs. Prior to the passage of the Federal Credit Reform Act of 1992 (FCRA), the United States budgeted and accounted for direct loans and loan guarantees on a cash basis. As money left a federal account, the U.S. government’s ledger reflected those disbursements as costs, and as repayments came back to the government, the collected funds flowed back to the Treasury. Depending on the relevant congressional committee and program, the lending agency received some credit for returning those funds in subsequent appropriations cycles. In general, however, this system pressured loan programs to lean heavily on less-cash-intensive loan guarantees—rather than providing direct loans—as an agency’s discretionary dollars could stretch farther on a guarantee than a loan.
The passage of FCRA and publication of the A-129 Circular by the Office of Management and Budget (OMB) addressed the distortive effect of this accounting treatment by allowing government loan programs to borrow the difference between the calculated subsidy cost for a loan and the total upfront cash requirements for the loan. Program staff no longer had an incentive to use one instrument over another, leading to lending decisions based on the appropriate instrument to achieve the desired policy outcome, not the protection of agencies’ annual discretionary resources.
Today, equity instruments are experiencing the same problem. The government’s accounting rules do not recognize the balance sheet value of those investments, and equity investments cannot utilize FCRA’s reforms to loan programs. To avoid future incentive distortion, agencies that use equity-like instruments need an FCRA-like adjustment to their accounting rules. On a theoretical level, this means developing a methodology for the budgetary treatment of equity. The net present value calculation used to determine a loan’s credit subsidy cost under FCRA is an inappropriate methodology, as equity investments can fluctuate in value and generate inconsistent cash returns, unlike loans with predictable payment schedules.
Equity Subsidy Cost Calculations
Instead, OMB and the Congressional Budget Office should evaluate the expected portfolio-level returns of an agency’s equity investment programs based on historical performance to assess the amount of upfront discretionary cash necessary for an agency to fund a particular equity investment, discounted by an appropriate risk factor. This risk-adjusted measure of historical program performance could then be used to estimate an equity subsidy cost, allowing an agency to borrow a portion of the money required to fund each investment from the government’s collective checking account at the Treasury, much like loan programs do today.
Establishing an equity subsidy cost calculation based on portfolio or program-level historical performance would encourage government program managers to consider the portfolio-level policy impact, financial performance, and risk of investment programs. Today, those same managers and senior government officials both over-rotate (i.e., frequently shifting many investments) based on the risks or potential policy impacts of a specific transaction. Good industrial policy and economic statecraft require placing many bets within a sector over a sustained period, then focusing resources to support national champions as they compete abroad.
An unintentionally profitable investment should also make space in the portfolio for a highly unprofitable investment with high levels of policy impact. The Department of Energy team that provided roughly the same amount of cheap capital to Solyndra and Tesla in 2009 and 2010 respectively should be rewarded for their overall portfolio performance, not the failure of Solyndra. Had these loans contained even a small amount of convertible warrants, the U.S. government would have reaped a nearly 500x return on its investment.
MOIC Methodology
Any methodology that helps calculate an equity subsidy cost should rest on the theoretical fundamentals of cash-based government accounting to avoid unnecessary disruptions to the entire accounting system of the U.S. government for a very small amount of niche spending activity. One possible method could be the historical evaluation of a program’s overall multiple-on-invested-capital, or MOIC, by OMB after a defined initial period of performance. MOIC describes the performance of an investment relative to its initial cost and is often used in private markets investing. At its simplest level, it shares some of the same focus on cash of government accounting rules, as it describes the cash-on-cash return to the investor from an original investment without necessarily considering periodicity.
The DFC’s program is intended to be a highly patient form of investment, which could remain in place for as long as a decade. A 1.0x average five-year MOIC would mean that DFC’s investments lost money over this period due to inflation but generally returned the invested capital to government coffers. But even if the equity subsidy cost for any individual investment in the portfolio is close to zero, equity is a powerful policy tool that should not be used lightly. Allowing equity subsidy costs to reach zero or below (i.e., a negative credit subsidy cost) would also be overly generous and fail to encourage the right impact-oriented investments. To prevent government program managers from chasing returns over policy impact, the following structure could be appropriate:
| Program Age | Equity Subsidy Cost | Rationale |
| < 4 years | Fixed 85% equity subsidy cost for all programs. | Some recognition that equity investments are assets on the government’s balance sheet but highly conservative equity subsidy cost to cabin risk/loss. |
| 4 - 5 years | OMB evaluates real and expected MOIC in year 4. Equity subsidy cost can fall as low as 65% for expected >0.9x MOIC within program defined timeline | Four years is usually adequate time to assess the expected ability of the government to recover its investments. |
| 5 - 7 years | OMB evaluates real and expected MOIC in year 4. Equity subsidy cost can fall as low as 65% for expected >0.9x MOIC within program defined timeline | Maximize subsidy cost without giving managers budgetary credit for profitability. For programs that exceed 0.65x MOIC, these programs will actually return more funds to the government’s coffers than they borrowed. |
This methodology avoids the need to value the assets in a program’s portfolio, which would create an accounting and compliance nightmare for the government, and prices in the relevant risk profile of investments over time. It also allows individual programs to work with OMB to set their intended periodicity for investments, while accounting for the interest expense of borrowing from the Treasury General Fund at or around the rate of the U.S. government’s own borrowing costs.
Conclusion
Tools matter in industrial policy; the architecture of U.S. accounting will affect how billions of dollars in U.S. government capital reshapes the world’s economy. To successfully implement this type of government-wide change three things would need to occur: OMB would need to publish a new circular akin to A-129, the Congressional Budget Office would need to agree on how to score these programs, and, ultimately, new legislation akin to the FCRA would need to be passed by Congress.
Although the DFC’s equity program is the only office within the U.S. government with a sufficient track record to apply this kind of historical returns-based methodology, this issue is urgent. Without reform, a generation of industrial strategy efforts is at risk. Updating the budgetary treatment of equity would pull government accounting rules, which are ultimately the basis for economic statecraft and industrial policy, into the twenty-first century government accounting rules.
What tools the United States should use to accomplish its policy objectives are at the heart of today’s policy debates. As most of the world’s advanced economies adopt complex financial instruments as preferred policy tools and Congress mulls creating a strategic investment fund for domestic or international policy objectives, there is no other choice. How and when to apply grants, loans, equity, tax credits, or other incentives can determine whether a particular sector of the U.S. economy can compete against similarly subsidized foreign rivals—and sometimes, whether the United States wins or loses control of chokepoints in the global economy.